Saving for retirement

- Let's consider a retirement example.This is going to take some imagination,but imagine that I am 25 years old fresh out of college.I have my first real paycheck,and I want to start buying some of those thingsthat I've always dreamed about a new car,a nice computer, take some trips.I don't want to think about retirement,after all that's 40 years into the future at least.Should I worry about retirement now,or should I wait until I havea little more discretionary income?Well, we'll consider two cases.In case one, I'm going to just put $100 a monthinto a savings account and let it accumulatefor 40 years at five percent compounded monthlythat will be my retirement savings.

In case two, I'm going to wait until I'm 45,hey that's still 20 years tillretirement if I start when I'm 45,and then I'm going to sock away $100 a monthfor those 20 years at five percent compounded monthly.How much difference will it make ifI wait to start saving for retirement,versus if I start saving right now?I'll illustrate using a calculator,but you can try the same thingwith a spreadsheet using the FV function,and you'll get the same answer.For case one, when I decide to start savingimmediately I would input the following.

Step one, clear the calculator's memory.Step two, key in 480 to represent the numberof months during my 40 year retirementsavings program and I press N.Step three, divide the five percent investment returnby 12 and input the result .416667,and I press the interest rate key,this represents my interest rate per month.Step four, I key in 100 and press PMTthis represents the amountthat I'm going to save each month.

Step five, I hit the FV key to see whatmy savings will amount to in 40 yearsin this case the answer is $152,602.In other words, if I invest just $100 a monthfor 480 months at five percent compounded monthlyin 40 years my savings will have grown to $152,602.Contrast this amount $152,602with the result I get in case two,assuming that I wait until I'm 45before starting my retirement savings plan.

Step one, let's clear the calculator's memory.Step two, key in 240 to represent the numberof months during my 20 year retirement savings programfrom the time I'm 45 until the time that I am 65.Step three, divide the five percent investmentreturn by 12 and input the result .416667,and I press the interest rate keythis represents my interest rate per month.Step four, key in 100 and press PMT this representsthe amount I'm going to save each month.

Step five, hit the FV key to see what my savingswill amount to in 20 years when I turn 65having started my savings plan when I was 45,in this case the answer is $41,103.In other words, if I invest $100 a monthstarting when I'm 45, so from 45 to 65,for 240 months at five percent compounded monthly,after that 20 year retirement savings plan whenI turn 65 my savings will have grown to $41,103.

The difference between these two cases is $111,499.I'll have 152,602 if I start savingfor retirement at age 25,and just 41,103 if I start saving for retirement at age 45.If we start early our investment grows a lot faster.We can even take this example one step further.If I want to have $152,602 available when I retire,the amount that I will have if I start saving$100 a month when I'm 25 years old,how much would I need to put aside each monthstarting when I'm 45 to get that same amount?I'll illustrate using a calculator,but of course you can try this same thingwith a spreadsheet using the PMT functionand get the same answer.

Step one is to clear the calculator's memory.Step two, key in 240, because I'm going to delaythe start of my retirement savings plan until I'm 45,so I'll have only 20 years or 240 monthsof retirement savings, and I'm going to press N, 240 months.Step three, divide the five percent investment returnby 12, and input the result .416667,and then I press the interest rate keythis represents my interest rate per month.Step four, key in 152,602 andpress FV this is the future value,this is the amount that I want to haveavailable in the future when I retire,so it's a future value or FV amount.

Recall that this is the amount that would be there if Istarted saving $100 per month immediately when I turned 25.Step five, hit the PMT key to see how much I wouldhave to save each month beginning when I'm 45 years oldfor the 20 years until I retire at 65 years old,so this is a 20 years retirement savings plan.Surely, this is a prudent approach to retirement,for 20 years I'm planning ahead.In this case, the answer I need to save each month $371.26.

In other words, if I figure I will need$152,602 when I retire at age 65,I can either start saving $100 per month at age 25,or I can save $371.26 per month when I'm 45.Either way when I retire at age 65I will have accumulated $152,602.The point is this, the earlierI start saving for retirement,and the earlier you start saving for retirement,the easier it is to accumulatea comfortable retirement nest egg.

Here's what I've seen with respect to retirement savings.First, just set up a regularmonthly retirement savings plan,just set it up and forget about it.Let it operate on autopilot,just have a certain amount per monthtaken out of your bank account,and put into your retirement savings plan.Second, periodically see how muchis in your retirement savings account,you'll be amazed and inspired how regular savingsand the power of compound interestcan turn your modest monthly savings amountinto a serious retirement fund.

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Released

4/6/2015

Learn how understanding the time value of money can help you figure out loan payments, save for college and retirement, rent or buy a house, lease or purchase a car, and make long-term business decisions. Accounting professors Jim and Kay Stice explain the linked concepts of the time value of money (TVM) and compound interest, show you how to calculate TVM in Microsoft Excel or on a calculator, and how to apply TVM to a variety of personal and professional financial scenarios.

Learn more about interest rates and investments in the Stices' Finance Fundamentals course.